Stacked against retirement

Saturday

Apr 12, 2014 at 12:01 AMApr 14, 2014 at 11:25 PM

THE ASSOCIATED PRESS

THE ASSOCIATED PRESS

WASHINGTON — A new study finds that the typical 401(k) fees — adding up to a modest-sounding 1 percent a year — would erase $70,000 from an average worker's account over a four-decade career compared with lower-cost options. To compensate for the higher fees, someone would have to work an extra three years before retiring.

The study comes from the Center for American Progress, a liberal think tank. Its analysis, backed by industry and government data, suggests that U.S. workers, already struggling to save enough for retirement, are being further held back by fund costs.

"The corrosive effect of high fees in many of these retirement accounts forces many Americans to work years longer than necessary or than planned," the report, being released Friday, concludes.

Most savers have only a vague idea how much they're paying in 401(k) fees or what alternatives exist, though the information is provided in often dense and complex fund statements. High fees seldom lead to high returns. And critics say they hurt ordinary investors — much more so than, say, Wall Street's high-speed trading systems, which benefit pros and have increasingly drawn the eye of regulators.

Consider what would happen to a 25-year-old worker, earning the U.S. median income of $30,500, who puts 5 percent of his or her pay in a 401(k) account and whose employer chips in another 5 percent:

If the plan charged 0.25 percent in annual fees, a widely available low-cost option, and the investment return averaged 6.8 percent a year, the account would equal $476,745 when the worker turned 67 (the age he or she could retire with full Social Security benefits). If the plan charged the typical 1 percent, the account would reach only $405,454 — a $71,000 shortfall. If the plan charged 1.3 percent — common for 401 (k) plans at small companies — the account would reach $380,649, a $96,000 shortfall. The worker would have to work four more years to make up the gap. (The analysis assumes the worker's pay rises 3.6 percent a year.)

With stocks having hit record highs before being clobbered in recent days, many investors have been on edge over the market's ups and downs. But experts say timing the market is nearly impossible. By contrast, investors can increase their returns by limiting their funds' fees. Most stock funds will match the performance of the entire market over time, so those with the lowest management costs will generate better returns, said Russel Kinnel, director of research for Morningstar.

"Fees are a crucial determinant of how well you do," Kinnel said.

In a 2009 experiment, researchers at Yale and Harvard found that even well-educated savers "overwhelmingly fail to minimize fees. Instead, they placed heavy weight on irrelevant attributes such as funds' (historical) annualized returns."

Americans hold $4.2 trillion in 401(k) plans, according to the Investment Company Institute. An additional $6.5 trillion is in Individual Retirement Accounts.

For years, companies have been dropping traditional pension plans, which paid a guaranteed income for life. Instead, most offer 401(k)-style plans, which require workers to choose specific funds and decide how much to contribute from their pay. Workers also bear the risk that their investments will earn too little to provide a comfortable retirement.

The shift from traditional pensions threatens the retirement security of millions of Americans. Many don't contribute enough or at all. Some drain their accounts by taking out loans and hardship withdrawals to meet costs. Sometimes their investments sour. And many pay far higher fees than they need to.

Of all those problems, fixing the fees is the easiest, Center for American Progress researchers Jennifer Erickson and David Madland say.

They are calling for a prominent label to identify how a plan's fees compare with low-cost options. That information, now found deep inside documents, shows the annual fees on investing $1,000 in a plan. Yet that figure, usually only a few dollars, doesn't reflect how the fees rise into tens of thousands of dollars as the account grows over decades. The researchers say the Labor Department could require more explicit disclosure without going through Congress.

Part of the blame goes to employers that offer workers high-fee plans.

"The good options are out there," said Alicia Munnell, director of the Boston College's Center for Retirement Research. "But when you introduce bad options into a plan, you attract people to them. There are a lot of people who think they should buy a little of everything, and that's diversification.

"I want the world to know that fees can really eat into your retirement savings."